CHAPTER ONE INTRODUCTION 1.1 Background of the Study The financial landscape of Ghana has gone through significant changes over the past three decades. In the 1970’s and the early 1980’s the economy of Ghana was characterised by a steady decline with hyperinflation and exchange rate depreciation being major features. The malaise that afflicted the economy took its toll on the banking and financial system of the country. Among ills bedeviling the financial system, the following may be mentioned as prominent: low capital base of banks, high risk concentration, large portfolio of non- performing loans, weak accounting and management information systems, weak internal controls and weak supervision and deficiencies in the legal and regulatory framework. Before 1983, the formal banking system in the country was dominated by state owned banks that had a monopoly in terms of their spread and operations (Hinson and Hammond, 2006). The current banking environment has however changed. Hinson and Hammond (2006) report that, with the passage of the universal banking law however, all types of banking can be conducted under a single corporate banking entity and this greatly reorganises the competitive scopes of several banking products in Ghana. Thus reform and deregulation has brought the banking sector into the competitive arena in terms of customers and products. Standard Chartered Bank Ghana Limited (SCB) has been operating in Ghana since 1896 and is one of the country’s first and oldest international business institutions in the country. The bank opened its first branch in Accra in June 1896. Its core business was being the sole distributor of silver coins to the Gold Coast now Ghana. The bank is currently situated in 19 locations all over Ghana and still maintains Accra as head office. SCB employs over 700 people nationwide and has a customer base of two million. The company offers varied
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Effects on Unsecured Loans on the Performance on Banks
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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
The financial landscape of Ghana has gone through significant changes over the past three
decades. In the 1970’s and the early 1980’s the economy of Ghana was characterised by a
steady decline with hyperinflation and exchange rate depreciation being major features. The
malaise that afflicted the economy took its toll on the banking and financial system of the
country. Among ills bedeviling the financial system, the following may be mentioned as
prominent: low capital base of banks, high risk concentration, large portfolio of non-
performing loans, weak accounting and management information systems, weak internal
controls and weak supervision and deficiencies in the legal and regulatory framework.
Before 1983, the formal banking system in the country was dominated by state owned banks
that had a monopoly in terms of their spread and operations (Hinson and Hammond, 2006).
The current banking environment has however changed. Hinson and Hammond (2006)
report that, with the passage of the universal banking law however, all types of banking can
be conducted under a single corporate banking entity and this greatly reorganises the
competitive scopes of several banking products in Ghana. Thus reform and deregulation has
brought the banking sector into the competitive arena in terms of customers and products.
Standard Chartered Bank Ghana Limited (SCB) has been operating in Ghana since 1896 and
is one of the country’s first and oldest international business institutions in the country. The
bank opened its first branch in Accra in June 1896. Its core business was being the sole
distributor of silver coins to the Gold Coast now Ghana. The bank is currently situated in 19
locations all over Ghana and still maintains Accra as head office. SCB employs over 700
people nationwide and has a customer base of two million. The company offers varied
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products and services mainly in the context of personal banking, small and medium-sized
enterprise banking and corporate or wholesale banking. These products and services have
made the company attractive to both personal account holders as well as private investors in
Ghana. The bank is listed on the Ghana stock exchange and has consistently remained the
highest-priced stock on the local bourse with a share price of GH¢38 per share as of October
2, 2008. The bank is also one of the first financial institutions to be involved in financing
import and export trade in products like cocoa, gold, bauxite and timber.
Lending is one of the main activities of banks in Ghana and other parts of the world. This is
evidenced by the volume of loans that constitute banks assets and the annual substantial
increase in the amount of credit granted to borrowers in the private and public sectors of the
economy. According to Comptroller (1998), lending is the principal business for most
commercial banks. Loan portfolio is therefore typically the largest asset and the largest
source of revenue for banks. In view of the significant contribution of loans to the financial
health of banks through interest income earnings, these assets are considered the most
valuable assets of banks. Loan portfolio is typically the largest asset and the predominant
source of income for banks. In spite of the huge income generated from their loan portfolio,
available literature shows that huge portions of banks loans usually go bad and therefore
affect the financial performance of these institutions (Comptroller, 1998). The Bank of
Ghana’s classifications of advances of the Banking industry indicated that unsecured loans in
the loss category increased from GH¢125, 196,732 in December 2007 to GH¢204,
978,569.00 in December 2008, indicating over 63% jump in bad loans. A report on the
performance of banks in 2006 indicated that among other factors, higher loan loss provision
accounted for a decline in the profitability of banks in 2005 (Bank of Ghana, 2006). The issue
of unsecured loans can fuel banking crisis and result in the collapse of some of these
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institutions with their attendant repercussions on the economy as a whole. Kane and Rice
2001) stated that at the peak of the financial crisis in Benin, 80% of total bank loans portfolio
which was about 17% of GDP, was non-performing in the late nineties. Indeed unsecured
loans can lead to the collapse of banks which have huge balances of these non-performing
loans if measures are not taken to minimize the problem. In Ghana, the banking industry
plays an important role in the development of the economy. Huge unsecured loans could
therefore affect banks in the performance of this important role.
1.2 Statement of the Problem
The current credit crunch has affected the performance of many banks globally. Thus
institutions that adopt strategies to compete better are more likely to survive in the long run.
The credit crunch poses a grave threat to the economies of the developed and developing
world. The global banking industry, which was by far the most profitable sector in 2006, is in
severe difficulty and the threat that this poses to the real economy is profound.
The world has experienced remarkable numbers of banking and financial crises during the
last thirty years. Caprio and Klingebiel (1997) identify 112 systemic banking crises in 93
countries since the late 1970s. Demirguc-Kunt and Detragiache (1998) have identified 30
major banking crises that are encountered from early 1980s and onwards. According to the
above researchers most of these banking crises were experienced in the developing countries
such as Ghana. Interestingly, the majority of the crises were caused by unsecured loans.
Persistent loan defaults have become an order of the day in developing countries such as
Ghana. There has been hardly any bank in Ghana which has not experienced persistent loan
default. This is evidenced by the under-capitalisation of the banking sector in 2009. Healthy
loan portfolios are vital assets for banks in view of their positive impact on the performance
of banks. Unfortunately, some of these loans usually do not perform and eventually result in
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bad debts which affect banks earnings on such loans. These unsecured loans become cost to
banks in terms of their implications on the quality of their assets portfolio and profitability.
This is because in accordance with banking regulations, banks make provisions for non-
performing loans and charge for bad loans which reduce their loan portfolio and income. For
example in February, 2009, a Bank of Ghana report revealed that non-performing loans ratio
increased from 6.4% in 2007, to 7.7% in 2008. In the light of the above, the issue of
unsecured loans has raised some concerns among stakeholders in the banking industry. The
study therefore seeks to find out how unsecured loans affect financial performance of banks
in Ghana using Standard Chartered Bank, Ghana.
1.3 Objective of the Study
The study has a general objective of establishing the main impact of unsecured loans on the
financial performance of Standard Chartered Bank, Ghana.
Specifically, the study has the following objectives:
To establish the trend of unsecured loans of Standard Chartered Bank, Ghana during
the past five years
To identify the factors that account for unsecured loans in Standard Chartered Bank,
Ghana.
To come out with recommendations that can address the issue of unsecured loans in
the Ghanaian banking sector
1.4 Research Question
Evolving from the problem statement discussed above, the study aims at providing answers to
the following questions:
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Which key areas of the Bank’s financial performance are affected by unsecured
loans?
What is the trend of Standard Chartered Bank Ghana unsecured loans over the last
five years?
What factors account for unsecured loans in the bank?
1.5 Significance of the Study
The study would contribute significantly to the development of the banking industry which
plays a pivotal role in the development of the economy. This is because the study seeks to
identify causes of unsecured loans in banks and recommend some measures that can solve
these problems. The findings would also enable management of banking institutions come
out with pragmatic policies for loan portfolio management aimed at improving the quality of
their loan portfolios.
The findings are expected to remind credit staff about the implications of their credit duties in
creating quality loan portfolio for their banks. The findings of this study could be seen as a
contribution to existing works on unsecured loans. Indeed, this would contribute immensely
in building up academic knowledge in a wide range of issues. The study would also play a
significant role of engineering further research into other aspects of the topic under
consideration or other related topics in the banking sector.
1.6 Scope of the Study
The study focuses on the Standard Chartered Bank, Ghana; one of Ghana’s largest and oldest
banks. This is premised on the fact that the Bank has been operating long enough to give the
kind of academic insight the study seeks to offer. Besides, the bank lends to almost all the
major sectors of the economy and as such the data needed to accomplish the work would be
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obtained without any hindrance. Conceptually, the study looks at all categories of unsecured
loans and their impacts on financial performances of the Standard Chartered Bank, Ghana.
Specifically, the impact of unsecured loans on loan interest income, profitability and liquidity
of the bank is assessed. The study also considers the sector that is prone to unsecured loans.
1.7 Limitation of the Study
Time was a major constraint in this study. As a result of limited time within which to
complete this work, the study was carried out using a case study approach. There was
therefore the possibility that some issues regarding the topic might not come up if such issues
are peculiar to some banks that were not covered in the study. The study was further
narrowed down to some loan officers and some management staff of the bank, from whom
primary data was obtained. This also posed a limitation since there could be some biases
regarding the information obtained.
1.8 Organisation of the Study
This study is divided into five main chapters. The first chapter contained introduction of the
study including the statement of the problem of the study, research objectives and questions,
significance of the study, scope of the study and the limitations associated with the study.
Chapter two focused on review of literature on the previous works related to unsecured loans.
Performing and nonperforming loans, bad loan provisioning, loan-making procedures and
monitoring of loans were also considered in this section of the study. The details of research
method and organizational profile were captured under chapter three.
Chapter four entails data presentation and analysis.
The Last chapter covered summary, conclusions and recommendations of the study.
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CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This chapter focuses on the review of relevant literature on loans and other core aspects of the
topic under study. The chapter thus presents the conceptual and theoretical basis for the
study.
2.2 Meaning of Banks
Over the years it has been a difficult task to find an acceptable definition of a bank or a
banker. Several attempts have been made to offer a comprehensive and acceptable definition.
Starting from the time of J W Gilbart(1847), he defined a banker as a dealer in capital, or
more appropriately, a dealer in money. Gilbart(1847), regarded banks as intermediate parties
between the borrower and the lender (Iganiga, 1998). This is because the banks borrow from
one party and lend to another. It will be observed that this definition emphasizes the two
traditional functions of a bank i.e. the mobilization of deposition and the granting of loans
and advances. But in recent time banks business has been expanded considerably and as a
result Gilbart’s definition cannot be regarded as complete or comprehensive.
In 1969, the Banking Act of England defined Banking by the following activities.
I. The business of receiving money from outside sources as deposit irrespective of the
payment of interest.
II. The granting of loan, acceptance of credit or the purchase of bills, cheque and sales of
securities.
III. The purchase and sales of securities on behalf of customers. (Isedu, 2001).
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Umole, (1985), points out that this definition fits better into the modern day role of banks in
the economy, because the definition goes beyond mere collection of depositor’s fund. The
banks, be it central, clearing merchant, saving or whatever form, pursue similar goals. They
contribute significantly to achieve the stated macroeconomic objective of economic
transformation.
2.3 Functions of Banks
2.3.1 Offering liquidity
According to Freixas and Rochet (2008), liquidity in Banking refers to assets that can easily
be converted into cash. Money in the form of cash is regarded as the most liquid asset in the
banking Industry. Historically, the existence of Banks is credited to this unique function of
providing liquidity to people and corporate bodies to carry out their daily business activities.
In order to perform this role banks offer saving, deposit and current account facilities to the
public. When a customer decides to operate an account, and pay a minimum amount as
specified by the banks, the amount deposited on the various account is held by the bank as
deposit liability. In addition to this, banks help in keeping other convertible equities, like
certificate of occupancy, share certificate, deeds of conveyance etc. The bank is therefore
requested by law to make a certain percentage of their deposit liabilities and capital funds
available to the bank customers, to meet customer demand (Idahosa, 2000).
2.3.2 Payment Service
A Bank is under obligation to pay back to the customer any amount as specified by the
customer according to the value of the account held (Freixas and Rochet, 2008). A bank
customer may also want his cheque cashed up to a stated amount and within a specified
period, at another branch of the bank or another bank. Conversely, the customer can also
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receive money through the bank when a debtor has decided to pay from a distance with
crossed or open cheque.
2.3.3 Lending Services
Idahosa (2000) asserts that the deposits kept in banks need not be left idle, because from
experience banks are aware that depositors may not need all the deposits at a time. It is
therefore prudent of the banker to lend such money to investors at a higher rate which brings
some revenues to them. They achieve this through overdraft, loan, bills discounting or
through direct investment.
Guilford (2008), points out that the significance of bank lending cannot be overstated. Bank
loans drive the economy. Bank loans provide the capital for businesses to start and expand.
According to Guilford (2008), the first step in attaining a bank loan is for a bank customer to
fill out a loan application. The application will include personal information, financial
information and questions about the purpose of the loan. Once submitted, the application will
go into underwriting, where the bank will make a decision on whether or not to loan the
money and at what rate of interest. The bank will investigate the customer's credit rating. If it
is acceptable, the bank will issue the loan.
2.3.4 International trade services
Isedu (2001) emphasizes that banks help to provide the link through which payments for
goods and services bought or sold by importers and exporters can be settled. In addition to
this, they provide guarantee to exporters who need such guarantees before they can release
their goods. Banks trade on foreign currencies. They engage competitively in foreign
currency transaction as it provides them a significant source of revenue. However, foreign
exchange transactions laws in every country are very stringent.
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2.4 Definition of Loan
According to Guttentag (2007), loan is a type of debt. Like all debt instruments, a loan
entails the redistribution of financial assets over time, between the lender and the borrower.
In a loan, the borrower initially receives or borrows an amount of money, called the principal,
from the lender, and is obligated to pay back or repay an equal amount of money to the lender
at a later time. Typically, the money is paid back in regular installments, or partial
repayments; in an annuity, each installment is the same amount. The loan is generally
provided at a cost, referred to as interest on the debt, which provides an incentive for the
lender to engage in the lending. In a legal loan, each of these obligations and restrictions is
enforced by contract, which can also place the borrower under additional restrictions known
as loan covenants.
2.5 Types of loans
2.5.1 Secured Loan
A secured loan is a loan in which the borrower pledges some asset for example a car or
property as collateral for the loan. A mortgage loan is a very common type of debt
instrument, used by many individuals to purchase housing. In this arrangement, the money is
used to purchase the property. The financial institution, however, is given security a lien on
the title to the house until the mortgage is paid off in full. If the borrower defaults on the
loan, the bank would have the legal right to repossess the house and sell it, to recover sums
owing to it. In some instances, a loan taken out to purchase a new or used car may be secured
by the car; in much the same way as a mortgage is secured by housing